Here are some lessons from last week’s epochal financial meltdown/bailout.
On the good side, we learned that the federal government can be powerful and decisive at a time of real crisis. Whatever you might think about the rescue plan drafted on the fly by Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson, it almost certainly will forestall an economic disaster of unparalleled scale.
We could become the Argentina of this century — a country destroyed by overspending, by frenzied speculation, by persistent budget deficits and by reckless government borrowing. That’s us, but unlike Argentina, we might be too big to fail.
The collapse of the U.S. financial system, which might have been hours away last Thursday, would have triggered a similar collapse worldwide. And once such a collapse had taken place, it would probably have been followed by a worldwide depression.
We should be grateful, believe it or not, to President George W. Bush, who hired both Bernanke and Paulson, and was smart enough to let them manage the crisis. The president has many virtues, but, like most of us, doesn’t understand the arcane financial instruments which precipitated the crisis.
We should also give credit to congressional leaders of both parties, who are working together and developing a policy, which would have been unthinkable even hours before, understanding that the future of the country is at stake.
On the bad side, we learned once again that ours is a nation that prefers drift and indecision to any action that might conceivably offend a powerful interest group. That’s why, as complex derivatives proliferated worldwide, and as investment banks, insurance companies and commercial banks were caught up in speculative frenzy, federal regulators did nothing.
Vast fortunes were made through financial manipulation and many of these “malefactors of great wealth” (as Teddy Roosevelt called the speculators of another era) got away clean. Willie Sutton, who famously remarked that he robbed banks because “that’s where the money’s at,” would have been envious — legalized bank robbery!
And while Paulson and Bernanke performed superbly at a moment of crisis, they, and their predecessors, failed miserably at Government 101.
This crisis didn’t happen overnight. It was years in the making, and could have been averted through relatively mild, largely technical regulatory changes.
But for years, both bankers and regulators looked the other way as speculation built a vast inverted pyramid of debt, resting on two obvious fallacies. Very smart people assumed, or pretended to assume, that real estate values would never decline. The same people pretended that the hundred-trillion dollar derivatives market was self-regulating, and that counterparty risks were perfectly matched.
This shadow banking system, as it came to be called, had nothing to do with systems or with banking — it was simply a means by which smart people could become rich without personal risk.
As the storm clouds gathered, there were those who well understood the risks of derivatives. Five years ago, Warren Buffett addressed the subject in his annual letter to shareholders of Berkshire Hathaway.
“Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal,” he wrote. “We view them as time bombs, both for the parties that deal in them and the economic system.”
And what did Alan Greenspan, the then-chairman of the Federal Reserve, say that same year?
“Although the benefits and costs of derivatives remain the subject of spirited debate, the performance of the economy and the financial system in recent years suggests that those benefits have materially exceeded the costs,” he said. “Except where market discipline is undermined by moral hazard, owing, for example, to federal guarantees of private debt, private regulation generally is far better at constraining excessive risk-taking than is government regulation.”
Greenspan, once a youthful disciple of Ayn Rand, took the position that private risk-taking shouldn’t worry regulators, as long as the government didn’t bail them out. Like Rand, he took a naively utopian view of financial markets, viewing them as engines of innovation governed by the “invisible hand” of the market.
He was wrong. The invisible hand was switching the cups in a shell game, and we’re the suckers — paying a trillion or so to bail out the scammers.
A few years ago, Vice President Dick Cheney remarked that “Reagan taught us that deficits don’t matter.”
That remains, it appears, the position of both presidential candidates, who are clinging to their expansive programs of tax cuts and new government programs. Would it be impertinent to suggest that deficits do matter, that our outsize debts must be paid, and that we can no longer afford the delusional politics of yesterday?
The Gilded Age ended last Thursday. It was fun while it lasted — for some of us.
Welcome to the reality-based community.
John Hazlehurst can be reached at John.Hazlehurst@csbj.com or 227-5861.